Death and taxes may be certainties of life… but it doesn’t mean we should not do all we can to put them off.
Many clients misunderstand regulations surrounding the taxable consequences when transferring funds from an employer-based retirement account such as a 401k or even an individual IRA account into an annuity. A lot of the challenge comes from how the IRS differentiates between a transfer and a withdrawal or distribution. Transfers or rollovers between qualified accounts allow retirement accounts to maintain their tax deferral status; whereas withdrawing or taking a distribution from a qualified retirement account can result in a taxable consequence – with the exception on withdrawals or distributions using the IRS sixty-day rollover allowance, allowed only once per year!
Watch as the Annuity Guys® discuss the complexities for avoiding tax when moving funds from a qualified account into a qualified annuity.
Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.
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Wonder what the alternatives might be if the government decides to increase revenues (taxes).
Retirement Account Cap With Obama Budget Buoys Insurance
by Zachary Tracer at Bloomberg
A cap that President Barack Obama has proposed on the size of tax-advantaged retirement accounts is seen as potentially pushing savers to another product that limits payments to the government: life insurance.
Obama’s 2014 budget plan, unveiled April 10, includes a proposal to cap at about $3.4 million tax-preferred retirement accounts such as IRAs and 401(k)s. That would encourage wealthy savers to put more cash into insurance — whose death payouts are typically exempt from federal taxes — and annuities, where taxes are deferred, said Walter White, chief executive officer of Allianz SE (ALV)’s North America life business.
“In our industry, in many ways, that could be helpful, because then you’ll start to look for tax advantages in other ways, and some of our products are geared toward that,” White said in an interview in New York.
Related content: Building a Financial Safety Net Special Report
Wealthy investors have long included life insurance as part of a strategy to limit taxes and pass on wealth to their heirs. The cap proposed in Obama’s budget would push more assets into life insurance and annuities as investors seek to limit taxes, said Ron Rubin, the CEO of Union Square Financial Partners LLC, which advises wealthy clients on transferring their assets.
Annuities are another type of insurance product that can offer a stream of income in retirement.
“We’re going to see a massive swing over to the after-tax, tax-deferred asset classes like annuities and life insurance,” Rubin said in a phone interview. [Read More at Bloomberg…]
Dick: Hello, I’m Dick.
Eric: And I’m Eric, and we’re the annuity guys.
Dick: Yes, we are, and Eric, one of the things that we run into a lot… it kind of amazes me folks but we get folks a call in or they’re in our office and the first thing they’re concerned about is they’re really interested in an annuity and doing an annuity, they’re afraid they’re going to pay tax… on their IRA or 401K…
Eric: The misunderstanding of how to get the dollars from everything they’ve saved up for their entire working career is sucked away in IRA’s, 401K, and they’re all sitting there. And they don’t want to pay this tax on what they’ve perceived is going to be as a distribution.
Dick: Right. Exactly. There’s an assumption of some kind of.. an assumption from folks of “well, if I reposition that money from that into this, then I’m going to pay all the tax.”
Eric: If you get a withdrawal, they would be right; however, you don’t need to do a withdrawal. What you want to do is basically do a rollover right from basically you’re IRA or 401K to an IRA annuity. So, it still stays within that IRA…
Dick: IRA wrapper, right.
Eric: And so, it still remains tax-deferred… so you don’t have that taxable consequence until you start taking distributions.
Dick: Well… and there’s so many different terms that are used. So many times we talk about semantics, one word will mean two or three different things – roll over transfer or we use rollover which typically to you and i and for most folks means a sixty-day rollover where you’ve actually taking control of the money and your going to roll it over. but then there’s the rollover transfer…
Eric: The custodian to custodian kind of a deal where your 401K is held with fidelity and all of a sudden we’re going to an insurance company. So it’s transferred from fidelity being the custodian to whoever the insurance company…
Dick: Which is considered a rollover transfer. And then another little twist on that is that the company can actually send the check to the client in the name of the company that is going to go to and that’s a rollover transfer which is different rules than the sixty-day rollover.
Eric: It’s basically defining then that the check is made payable to the company that it’s going to go to rather than the individual.
Eric: Where people get in trouble usually is when the check is made payable to them. Although you do have that sixty-day period basically…
Dick: Well, and if you understand how to use that sixty-day period… it we can be used to their advantage and the sixty-day rollover just gives you time to take control of your money. You can actually co-mingle it which i don’t always recommend, but you can do it. And there’s nothing wrong about it. You just have to get that exact amount of money within sixty days back into a qualified account and that would be like in IRA, 401K or something of that nature.
Eric: Right. So we should fully disclose here; neither one of us are accountants.
Eric: Well, we do play them here on television right now. You always want to confer when you’re doing these transfers expecially if it’s not a straight transfer from custodian to custodian, to make sure your accountants are aware that if you did take possession of funds into a sixty-day rollover because you have to make proper notification to the IRS which…
Dick: And folks, Eric and I give general tax advice on a regular basis, always with the caveat that you want to look at your individual situation with your accountant directly; will even give our clients a lot of times exactly what we want them to take to the accountant and what the accountant should understand about this. And many times the accountant will call us and say “hey, let me just get this straight what we’re doing here”… and it works out very well. Now, I have done personally many sixty-day rollovers and the reason I’d chose to do a sixty-day rollover, when money is moving out of an IRA or 401K is I like the paper trail and I like the fact that when you’re moving the money – it’s not between two large companies and their clerks on each end which get things confused – now they’re only sending a check directly to the client, the client receives the check, endorses the back of the check over to the company it’s going to go to; it speeds the process up dramatically, less errors and typically this can be done in a two-week period using overnight mail so that you’ve got tracking numbers. And it’s very, very efficient. On the other hand…
Eric: I’m more of a custodian to custodian…
Dick: Eric is more of a transfer guy.
Eric: Yes, I’m a transfer guymbecause the real reason is it really takes the IRS for the most part out of play. The transfer paperwork goes from one custodian to a another custodian; there is no usually issue with the IRS saying “no, you took that as a distribution sent to you because it’s going from one company to the other.”
Dick: Less of a possibly for any type of a mixed up. And even when they’re is a mix up which I’ve had had or seen happen, it’s very easy to straighten out as a rule because you’ve got all the documentation of the money went from here to here, and you’ve got tracking numbers and all of that. So, it really comes down folks to sometimes just personal preference in that you’re more comfortable with… and I kinda explain it both way to clients and Eric does also so that the client can make a decision which way they feel comfortable with.
Eric: We give you our advice and tell you what the options are.
Dick: Now, one thing Eric I want to bring up here… every once in awhile, someone you know talks to us he gets an inherited IRA and the problem with an inherited IRA is that you can’t do a sixty-day rollover.
Eric: That one’s got to go custodian to custodian.
Dick: It has to, right or that will be an instant taxable event. So pretty much, if you’ve inherited an IRA, you have to choose where you want that money to go if you’re going to move it and let that country move it to the other company. There’s been several cases where a stockbroker or financial planner where they did not understand it, went ahead and said “hey, we’re going to cut you this check and you can do what you want with it, you got sixty days to roll over.” The minute that check was cut the tax man’s at the door.
Eric: That’s right.
Dick: There’s no way out. You don’t get out of that.
Eric: Right. Reminds me of some of the questions we just received recently was about in-service distribution. And some of the confusion that happens when a person who has a 401K typically and they would like to take heavy option of taking dollars out perhaps before they’re finished working. Some of the more recent plans – and these are the qualified plans, these are the 401K plans, allow for an in-service distribution. Now that in-service distributions, you’re going to continue to work but they’re going to give you the option of moving those dollars…
Dick: Some of the money or all of the money out; and a lot of the reason why they did this folks was because these 401K plans were locking up the money and they didn’t have many choices and people were losing their money. And so now the companies are getting sued and they’re saying “this is not so wise to force people to stay in this 401K… and this always goes back to your plan with your employer; and someone who actually understands the rules because all this is is a simply a rollover…. 401K to an IRA rollover.
Eric: Exactly. And then you can position that IRA with an annuity or with your own self-directed IRA.
Dick: It’s all established by the IRS guidelines and the only question comes into play here is “does your plan, your employer that device your plan allow an in-service distribution”… and that means that your money’s moving before you retire.
Eric: And most the plans in the last five years have that option because the very reason you’re talking about… if it’s a somewhat older plan, you may not have that flexibility.
Dick: A lot of the older plans that have had a rude awakening, they’re going to allow it… but some of them don’t.
Eric: Yes. Alright, one of the last thing I want to talk about is Roth conversions. We’ve talked about taxes and if you’re really trying to avoid tax, there’s a little tricks you do with a Roth conversion.
Dick: Yes, there are.
Eric: And as far as tax…. i mean…
Dick: Well, one of one of the things that we talked about and that we work with clients on is that before you actually move your money to an annuity because frequently an annuity gets a nice bonus… nice bomb right upfront, ten percent… five percent… eight percent. So, if you’re going to get a nice little increase, why not have it all be tax-free? Tax-free is a good thing, Eric.
Eric: I want the tax-free without one.
Dick: Yes, I’ll take that one.
Eric: So, how do you do? Well basically it’s doing the Roth conversion.
Dick: Let’s just say your money is sitting at Ameritrade – we said fidelity – or what’s the other one?
Dick: Okay, so your money is sitting there and your getting ready do an annuity; well it’s pretty tempting to just get that money over an annuity and get that ten percent bonus but you know that you’re thinking real soon about converting it to Roth. Why not convert it to a Roth first?
Eric: Pay the tax because your going to pay the tax upfront.
Dick: But you’re going to pay the tax in April… so all you have to do is a paperwork.
Eric: Pay the tax before you convert it, get the bonus on a tax-free money.
Dick: Exactly. Technically, you’re paying the tax on the the pre-annuity money, you move it in there and all of the sudden you’ve got ten percent more and it’s all tax free… Not a bad deal.
Eric: Yes, it’s a way of not cheating uncle sam but it’s basically a way of keeping his hands in a small portion of the pie.
Dick: Just give him a poke on his ribs.
Eric: So, and i guess the one thing we want to clarify as we’re talking about tax on 401K’s IRA’s, it’s tax deferred here… you’re deferring the taxes, you’re not avoiding tax, you’re deferring it. It’s going to start coming out when you start making withdrawals and distribution.
Dick: Correct. And what your really doing is just avoiding a big amount of tax all at ones by doing a proper transfer, a rollover.